With the end of the year just around the corner, many employers may be contemplating giving year-end bonuses to their non-exempt employees. And bonuses, year-end or otherwise, can create problems for employers when it comes to calculating overtime compensation for those employees.

One mistake some employers make concerns calculating an employee’s regular rate for purposes of paying overtime premiums.  Indeed, many employers have found truth in the adage “no good deed goes unpunished” after implementing bonus policies or issuing other forms of compensation intended to reward employees, only to later discover that those payments had the unintended effect of increasing their employees’ regular rate and, thus, the overtime premiums that those employees should have received.

While this article focuses solely on the regular rate under the Fair Labor Standards Act (FLSA), employers should consult legal counsel to ensure that their compensation policies and calculations of overtime premiums comply with the FLSA as well as all applicable state and local laws.

What Is The Regular Rate?

The FLSA requires employers to pay non-exempt employees “at a rate not less than one and one-half times the regular rate at which [an employee] is employed” for all hours worked in excess of forty hours in a workweek.  29 U.S.C. § 207(a)(l).  The regular rate includes “all remuneration for employment paid to, or on behalf of, the employee,” subject to eight statutory exclusions.  29 U.S.C. § 207(e).

The amount of overtime pay due to an employee is a function of the employee’s regular rate of pay and the number of hours worked in a workweek.  Wages may take many forms, such as hourly pay, salary, commissions, piece-rate, tips, bonuses, meals, or lodging, but in all such cases the overtime pay due must be computed on the basis of the average hourly rate derived from such earnings.  This requires dividing the total pay for employment (except for the statutory exclusions) in any workweek by the total number of hours actually worked to determine the regular rate.

The regular rate depends on an employee’s actual earnings and hours worked and is not subject to contrary agreement, insofar as an employer must pay at least the minimum overtime premium required by the FLSA.  Under the FLSA, the formula to compute the regular rate for the workweek is as follows:

Regular rate = Total compensation in the workweek (minus statutory exclusions) ÷ Total hours worked in the workweek.

Exclusions From The Regular Rate

As noted above, the FLSA identifies a number of types of payments that do not become part of the regular rate of pay when calculating overtime compensation.  29 U.S.C. § 207(e).

Generally speaking, all remuneration for employment, including bonuses, presumptively goes into the regular rate calculation.  29 C.F.R. §§ 778.208, 778.211.  However, there is an important exception to that rule for discretionary bonuses.

Discretionary bonuses paid in recognition of services performed during a given period and paid at or near the end of that period can be excluded from the regular rate if (1) the fact that such bonuses are paid, and (2) the amount of those bonuses are left to the sole discretion of the employer.  29 U.S.C. § 207(e)(3); 29 C.F.R. § 778.211.

If an employer has promised, agreed, or contracted to pay employees a bonus such that the employees expect to receive it, such a bonus would not qualify as discretionary under the FLSA, and, thus, would be included in the regular rate for purposes of calculating overtime compensation.  For example, bonuses issued pursuant to a policy that compensates employees when they hit certain metrics do not ordinarily qualify as discretionary.

On December 12, 2019, the Department of Labor (DOL) announced a Final Rule to clarify what perks and benefits can be excluded from an employees’ regular rate of pay.  The Final Rule provides a non-exhaustive list of discretionary bonuses, including: severance bonuses, referral bonuses for employees not primarily engaged in recruiting activities, bonuses for overcoming challenging or stressful situations, employee-of-the-month bonuses, and other similar compensation.  29 C.F.R. § 778.211.

However, the Final Rule explicitly states that the label an employer gives to a bonus does not determine whether it qualifies as discretionary.  Similarly, the mere fact that a bonus may be paid in December or January, rather than earlier in the year, is irrelevant to whether it can be excluded from an employee’s regular rate.  29 C.F.R. §§ 778.211.

Non-Discretionary Year-End Bonuses Increase Employees’ Entitlement To Premium Pay For All Overtime Hours Worked During The Period The Bonus Covers

Once an employer pays a non-discretionary bonus, it must recalculate the employees’ regular rate for the entire time period covered by the bonus and pay employees additional overtime premiums for any overtime hours worked during that time period.  29 C.F.R. § 778.209.

For example, if an employee worked 50 weeks in the year and received a non-discretionary bonus of $1,000, the employer would have to recalculate the employees’ regular rate to include $20 ($1,000 ÷ 50 weeks) of additional compensation for each of workweek in which the employee worked overtime and divide that additional compensation by the number of hours worked in each of those weeks.

Thus, if the employee worked 40 hours, the employee’s regular rate would increase by $0.50 ($20 ÷ 40hrs), and the employee must then receive an additional amount of compensation equal to one-half of that amount ($0.25) multiplied by the number of statutory overtime hours worked during the week.

An alternative to this calculation is to divide the bonus by the number of hours worked in the entire time period, thereby identifying the effect of the bonus on the regular rate across the time period, and then pay the additional half-time overtime.  Thus, using the same example above of a $1,000 annual bonus, and assuming that the employee worked 2,000 hours in the year, the result is an increase of $0.50 in the average pay the employee received for each and every hour during the year.  The employer would then address the overtime by paying an additional $0.25 of premium pay per overtime hour worked during the year.  See 29 C.F.R. § 778.209(b).

For this reason, employers should confirm whether any year-end bonuses they pay non-exempt employees satisfy the requirements of a discretionary bonus under the FLSA.  If employers inadvertently treat non-discretionary bonuses as discretionary and fail to include those bonus amounts in their employees’ regular rate, they may be in for a nasty surprise when they receive a demand letter seeking unpaid overtime premiums for an entire class of employees.